Will China devalue? We doubt it

• Talk of CNY devaluation has hit the headlines lately as upward pressure on USD/CNY continues.

• We doubt China will turn to such a move. PBOC is currently taking measures to slow the decline, not increase it. And a devaluation is a risky move that could undermine efforts to support the equity market, trigger capital outflows, and add fuel to the fire in trade tensions with US and EU at a time when China is running a 5% trade surplus.

• We do, however, look for PBOC to allow for a small and gradual move higher in USD/CNY from 7.25 towards 7.30 in 12 months as depreciation pressure persists due to relative strength of the US economy.

Recently, there has been rising talk of a possible CNY devaluation. China has stockpiled some commodities, which has led to speculation that it plans to devalue the currency. At the same time, the Chinese economy is still struggling more than a year after coming out of Covid and giving a boost to exports through a devaluation could support the manufacturing sector. A weaker currency would also alleviate the deflationary pressures. These seem to be good reasons why China might want a weaker currency. Nevertheless, we see the odds skewed towards China refraining from a devaluation and offer our key arguments below. We would only put a probability of around 20% of a devaluation taking place.

Before turning to the arguments, let’s first define what we mean by a devaluation. We see a devaluation as either a deliberate decrease in the value of a country’s currency in order to boost exports or a country giving up its defence of the currency in a fixed or semifixed regime that leads to a sharp decline in the currency. For a CNY decline to be characterized as devaluation it would in our view imply a) that China stops its actions to slow the depreciation and b) that we see a rapid decline of the yuan within a short period by at least 5-10% versus the dollar. Hence a move to around 7.80 from the current levels of 7.25.

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